February 4, 2017
The Thick Of It
It's earnings season, and the generally positive mood about forward-looking earnings potential is keeping the averages afloat after the significant post-election run. As of the last day of January, the Dow Jones Industrials have gained 8.35% since election day, November 8th. The S & P rose 6.5%, the Nasdaq gained 8.13%, and the Russell 2000 soared 13.97%! The so-called “Trump Rally” had ridden the wave of expectations. I would say the market was unprepared for a Republican sweep, and therefore investors were in the wrong sectors. As the wave of portfolio adjustments gave rise to new leadership in Financials and Energy, money was chasing the same rabbit.
Look at January. “As go January, so goes the year.” That old adage may prove to be true. If you reduce regulations, healthcare requirements, and pollution controls, then companies will make more money. The market reflects earnings, not societal concerns. January might serve as a bit of a short-term warning. We are seeing divergences. January was up. The Dow barely held onto positive ground, up 0.52%. The S & P was up a modest 1.79%. Tech stocks helped lift the NASDAQ in the last week to gain 4.31%. But the Russell squeaked by with a gain of 0.37%.
The rationale behind January’s adage is that portfolio managers position themselves with core holdings looking at the up-coming year, as a whole. If the outlook is positive, January is up. If Trump can push through deregulation and pass an infrastructure spending plan, 2017 should be bullish for stocks. On the flip side, 8% GDP growth to pay for his plans are a pipe dream, especially if the Republicans can push through tax cuts. Sorry. Higher debt, higher rates, and inevitable inflation could have us talking about the bear in 2018 or 2019, but for now everything is coming up roses.
Another warning sign comes in earnings season. Early reports have “coattails” to their industry group. A good report will give a boost to all in the same field. The second wave is that company reports need to be as good as the revised expectations to gain any more ground. Finally, when companies beat earnings, but go down anyway, it’s a sign that the market has priced in all the good news for now. Apple reported after the bell. The stock is doing well (+3%) in after-hours trading. Watch it closely Wednesday to see if it can hold, and help hold the overall market steady. If it fails, it is a yellow flag warning that we are near the end of this rally phase.
We don’t have big technical divergences. The Dow Jones Transports made a new high, as have the big three indices. However, the strong leadership in the Russell has faded and we did not confirm. Let’s just say that is a cautionary flag. Since early December’s peak, we can look at the last 7 weeks as a “distribution”. There is support below, which is solid. However, February is typically the worst month of the year, as profit-taking follows the historic November-December-January rally. We look to have the make-up of such a pattern. Momentum indicators, such as the MACD, have diverged for all but the NASDAQ. Again, a modest warning sign.
Markets tend to have a few 5% pullbacks in a calendar year. It is unusual to have more than one 10% plus pullback if we are still in a bull market. The current expectation should be for a 5% to 7% pullback. Those levels equate to Dow 19,095 to 18,693, assuming we don’t make a higher high in the next week. For the S & P, that would target 2183 to 2137, a 5% to 7% decline. The NASDAQ has a higher beta, so let’s say 7% at 5264. Put your political feelings aside. Don’t act on emotion. Yesterday’s recovery off of a very negative open is an indication of what the market can do after it shakes off the emotional reactions seen in early trading. If you like stops, tighten them up a bit. We may squeak out another week of rally, but we can feel the wind in our face.
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